Curve flattening is about a lack of yield, not a recession indicator

Relentless flattening of the yield curve is more about the shortage of yielding assets then some recession precursor

If one chart has caught my eye over the course of the last several months, it is the following illustration from the IMF that starkly how little yield exists in the world. While this is something all of us claim to know, I really do not believe that it gains enough attention, especially when we make assessments about the valuation of all asset classes. There is simply not enough yield to go around and this implies that the price investors are prepared to pay for quality yield will continue to rise until something change.

What will change? With the supply / demand mismatch being so pronounced, the only change will come from Central Banks pushing cash rates higher in response to inflationary pressures that, as we stand today, do not exist. So without inflation, sovereign yields will not rise and without rising sovereign yields, there will be little to stop the continuation of higher multiples being paid for all assets from investment grade debt, all the way to commercial real estate.

This is reflected by the spread between US 2's / 30's continuing to flatten, which coincides with lowered inflation expectations as signaled by US 5 Year inflation break-evens. With global growth remaining solid, recession concerns are way off base. Looking the yield curve as a predictor of recession is completely antiquated.

This is the primary reason why I remain so constructive on global risk assets in 2018. If bond volatility is going to remain so muted, then multiples will continue to expand. If yielding assets are in such desperate short supply, then the demand from global investors for US treasuries will remain elevated. US / German 2 Year spreads at near 2 decades wide drives home this point.

All being equal, this should imply Euro weakness versus the USD. Unfortunately the size and scale of the European Current Account Surplus will make trading the Euro difficult as these two cross currents collide. G10 currency trading to remain difficult in 2018 with the exception of the GBP. That is a train wreck in my opinion.

Thank you to the Wall Street Journal's Daily shot for the majority of these charts

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Thank Paul



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